As I reported in last Thursday’s blog entry, last week the research institute associated with China’s Ministry of Finance published a report on its website arguing that China’s central bank should “actively guide” the yuan’s exchange rate and devalue the currency to about 6.93 against the US dollar. The purpose of depreciating, the report said, was to help maintain economic growth and bolster employment
An exchange rate of 6.93 implies a depreciation of 1.5%. This is not much of a big deal and unlikely to make much of a difference in Chinese export prices, so I wonder why they would even say this except as a trial balloon. It is not just the research institute that has been making the devaluation argument. Although a number of officials have publicly called for stability in the exchange rate, within China there has been a heated debate about the country’s currency strategy, with several prominent commentators and economists arguing that China needs to devalue the yuan, by substantially more than 1.5%, so as to help Chinese manufacturers achieve greater competitiveness in the global export markets.
I think this kind of talk shows how mutually incompatible China’s two policy objectives are in the short term. First, China wants to boost domestic employment by boosting investment and helping restore manufacturing profitability. Second, China is under pressure, and this will almost certainly increase, to reduce its export of overcapacity, and China must address this pressure before it leads to worsening trade friction.
These policy goals might not seem mutually contradictory on the surface, but I would argue that this is only because policymakers – and many commentators, it seems – are failing to distinguish between total demand and net demand. Global demand is contracting, so anything that China does to boost total domestic demand is good for the world, right?
Not necessarily. Domestically, any increase in total demand will have positive implications for employment, but globally the world needs increases in net demand – that is, consumption minus production. Since China provides negative net demand to the world (it runs a trade surplus), what the world needs from China as global demand contracts is a reduction in the amount of negative net demand China provides.
China can boost total demand by boosting manufacturing – every worker not fired is a worker able to consume more – but boosting manufacturing also boosts Chinese production. If it increases production relative to consumption, then China is actually reducing net demand, even while it is increasing total demand. That this is happening, by the way, shows up in the rising trade surplus.
In that light devaluing the currency would be a mistake. Although it might make Chinese manufacturing exports seem more competitive in the near term, there are at least two sets of problems with devaluing the yuan. First, as should be very apparent, the slowdown in China’s exports is not a function of rising domestic costs but rather caused by declining global demand. With imports contracting rapidly, it is a mathematical necessity that countries like China that export excess capacity will, in the aggregate, be forced to export less. The fact that China’s exports have contracted by much less than most of its Asian trading neighbors suggests that in fact China has suffered much less than the average Asian exporter from the contraction in global demand, which makes the argument that China is losing export competitiveness hard to sustain. In that case devaluing the currency would almost certainly set off competitive devaluations.
Some in China are arguing that other Asian countries are already devaluing, so by devaluing China would simply be keeping up, but this argument is a weak one. With Chinese exports declining by less than other Asian countries, and the Chinese trade surplus rising, it will be hard, as I point out above, to argue that China has lost trade competitiveness.
More importantly China is the third largest economy in the world and has the largest trade surplus in the history of the world. It cannot act as if it were a Vietnam, whose economy is small enough that devaluation would only have a slightly negative impact on the global balance. China must understand the impact of its actions on the global, which necessarily must constrain its behavior.
This is because with global demand contracting, any attempt by China to force more overcapacity onto a struggling world – i.e. reducing net demand even further – will require an even sharper contraction in manufacturing among its trade partners. China’s trade surplus is the measure of the amount of overcapacity, or negative net demand, it is exporting into the global economy, and January’s astonishingly high trade surplus of $39 billion, the second highest on record, caps a six month period during which China’s already record-breaking trade surpluses have surged. But with global demand contracting, any increase in China’s trade surplus requires that manufacturers in the rest of the world on average must cut production and fire workers by more than the amount implied by the global contraction in demand.
This will almost certainly lead to widespread claims that China is playing unfairly. Already China is in serious trade disputes with India and Indonesia, and with protectionist sentiment on the rise in the US, Europe, and the rest of the world, this is not the time to create more protectionist fury. A devaluation of the yuan, however small, would be seen as China’s answer to the Smoot-Hawley tariff increase, the notorious bill passed by the US Congress in 1930 that put the nail in the coffin of international trade (and a great example of the US failure to understand in 1930 that, like China today, it was too big to ignore the global impact of its domestic policies). In that case devaluation would almost certainly lead to an increase in trade friction.
In the 1930s, Smoot-Hawley had that very effect, and as the country with the world’s largest trade surplus in the 1920s, the US found itself, ironically, as the greatest victim of the contraction in world trade it did most to sponsor. As I have argued many times in a world of contracting demand, it is countries with excess capacity or negative net demand – the trade surplus countries – who are most vulnerable to a collapse in international trade. Even more than the US in the 1930s, China would suffer enormously from trade war.
The second set of arguments against devaluation involves a little longer term thinking, and so might easily be ignored in the panic of the crisis, but China’s economy must make the transition from export orientation to reliance on its domestic market. The process is never easy. To devalue the currency now would mean failing to take advantage of the shift that is already taking place and would push the economy in the wrong direction – that of further constraining already-too-low domestic demand, while increasing the importance of the export sector in the Chinese economy. The difficult transition from export reliance to reliance on domestic consumption is not a problem that can be evaded, and postponing it will only make the transition worse.
As counterintuitive as it may seem, I think China should actually continue revaluing the yuan, but before doing so it must reach an explicit agreement that in exchange for revaluing, its trade partners will maintain open markets for China’s exports. This is key, and on Wednesday I think I will have a piece in the Financial Times that tries to make this point very explicitly. A trade war would force China to adjust quickly, and I think that would be socially disastrous for China, and at any rate given the structure of the country’s financial system and development model it cannot make the transition quickly.
As the world’s leading provider of excess capacity, China cannot avoid a difficult adjustment in a world of collapsing global demand. The goal of policymakers must be to slow the necessary adjustment over several years by negotiating an orderly decline in global trade imbalances. This requires cooperation, not devaluation. Sunday’s softer G7 communiqué which, according to an article in today’s the Financial Times, “adopted milder language than recently regarding China’s handling of its currency,” is a welcome step towards more civil discourse, but it should not mask the risk of rising protectionism. Among themselves the G7 can be as diplomatic as they like, but governments respond to domestic pressure, and nothing creates pressure like rising unemployment. Japan’s awful 2008 Q4 GDP numbers (down an astonishing 12.7% on an annualized basis) shows just how heavy that pressure will be.
I am off to Washington DC later today to testify before the US-China Commission and meet a bunch of friends in Treasury and State. On Saturday I will try to write about what I hear there.
China is a “Mammoth that believes that its a possum” like in the movie Ice Age. China does not realise how big it is in manufacturing and how small it is in consumption on a global scale.
Very crudely, China’s treatment of its currency, and trade barriers will have lasting and determining impact on the future of the world. China can become the economic super-power – but unlike the US (during post world war II) it does not have room to make mistakes.
But hasn’t China already enacted a scaled back version of Smoot-Hawley? There are non-tariff based restrictions on imports of a wide range of capital imports already, not to mention explicit domestic sourcing requirements in line with domestic industrial policies. There are still export rebates on a wide range of gooods, which in terms of relative prices are equally as distorting as a tariff on imports. So is deflation, and given the amount of excess capacity, it would not be the least bit surprising to see China’s unit export prices for consumer goods fall, and soon. This will amplify the existing distortions to relative prices even more, increasing the liklihood that foreign governments will respond with some sort of tariff escalation.
> If it increases production relative to
> consumption, then China is actually reducing
> net demand, even while it is increasing total
> demand.
No. If the production is fed back into investment and government spending, then net demand doesn’t change. China can increase demand by increasing investment. This will lead to increases in future production, which leads to future increases in standard of living.
There are several variables here, and I don’t think that increasing the consumption variable is a good thing. The variables that can be increased are investment (although this requires effort to make sure that it ends up in efficient investment) or government spending on public goods.
One of my suspicions is that the reason that we are in this mess is that the prevailing economic theories, remove variables from the demand equation so you end up with something that doesn’t balance.
If you end up being a market fundamentalist then you can’t adjust the government spending part of the equation. If you think that the market allocates investment optimally, then you remove the investment term of the equation. If you then believe that trade should balance then net imports disappears. That gives you consumption as the only variable that you can change.
But then you run into a situation in which a demand shock causes market psychology to push consumption down, at which point you have nothing to suggest except let the economy fall apart.
You run into the same problem with the controls you use. The only two “valid” controls in Greenspanism are the interest rates and by implication exchange rates. If you argue that government spending should be minimial and trade should be balanced, that gives you only interest rates, at which point you run into problems because you have conflicting requirements (full unemployment versus efficient credit allocation) which you can’t match by fixing one number.
In a lot of ways, the prevailing economic theories have painted themselves into a corner by systematically throwing away any controls and variables that can prevent or get us out of a mess. But it’s important here to point out that this is a prison of one’s own design.
The other issue is that a lot of this is the result of trying to create a universal economic theory. If you start looking for economic controls, you will find that a lot of them are specific to one economy. For example, increasing or decreasing SOE dividends is a control that is available in China rather than the US, whereas changing the overnight interest rates on commercial paper is available to the US, but not China. None of this is available if you try to make things too abstract.
I think that the events in the world have illustrated the failure of monetarist economic theory. Yes you could argue that things would be perfect if people acted according to the theories and you didn’t have to deal with annoying things like political reality, but any economic theory that only works when people stop behaving like people can’t be that useful, can it?
Personally I think that China should go to the position that it took during the Asian Crisis and commit to peg the RMB against the dollar. I really don’t see how devaluing is going to help China, because it will lead to a round of competitive devaluations. Given China’s huge foreign exchange reserves, there is no requirement to devalue.
Also, discussions of net and total demand have to include the fact that Chinese imports tend to be raw materials, and exports tend to be finished goods. Which means that US/China trade balance may behave in ways that are radically different from those between China and the rest of the world.
Finally, there are two US-China committees. One is the CECC which I have a lot of respect for, and the other is the US-China Security Review Commission which I don’t. The problem with the CSRC is that I get the since that they’ve already decided what they are going to say, and so talking to them isn’t that useful.
[...] Death of old economic theories and birth of new ones Filed under: china, finance — twofish @ 9:31 am http://mpettis.com/2009/02/should-china-devalue-the-yuan/ [...]
Hi Michael,
Have a good trip.
I can’t imagine the repercussions if China creates another Smoot-Hawley situation. This is dangerous for a trade-surplus country.
Michael Pettis’s top priority now is a PR campaign, rather than an economics analysis. Dr. Pettis can, and should win Nobel Price if he can convince the Chinese government to take his advice into policymaking to overcome the current financial crisis. It would be an enormous contribution, not only to China, but also to the recovery of the world from the economic downturn.
“China has suffered much less than the average Asian exporter from the contraction in global demand” . . . ok, to the extent we trust numbers provided. Even if we trust China’s numbers (I do not) is the situation at all sustainable? Lol! Does anyone believe the trade collapse in Taiwan, S. Korea, Japan, etc. is somehow “decoupled” from China?
If you look independently at the length of time it will take for China to develop its consumers, and the length of time it will take for overextended US consumers to rebuild their savings, and the length of time it will take to deleverage the developed economies, each of these problems will take years [perhaps many years] to solve. And if protectionism occurs because of shortsighted political pressures, the resolution of these problems could stretch out over a decade, just like in the Great Depression.
Michael, Good luck in DC. Your insight into China’s current role vs the US’ in the Depression has been most valuable. Keep up the good work!
I agree that it would be unwise for China to devalue its exchange rate, since one defence against charges of currency manipulation is that the renminbi has essentially only appreciated against the dollar since 1994. But I would question your characterisation of China as “the world’s leading provider of excess capacity”. It seems to me that, if China’s capacity is competitive at a long-standing exchange rate, it is the rest of the world that has the excess capacity. Given that the US etc want to borrow for fiscal stimulus, I wonder if it would be better if they stopped complaining about China’s current account surplus, but started using the implied resource borrowing to adjust their own economies away from the industries in which they are no longer competitive.
I often hear the argument that a failure to revalue the yuan (reminbi?)will result in social unrest in China.
I think it’s important to remember Tianamen Square. Social unrest in China is treated very differently than it is in the West.
I think far too many people are projecting Western values onto the Chinese leadership.
1. What is the risk of deflation in China? Does this give China the opportunity to maintain the peg without having to sterilize? How about RMB devaluation to fight deflation?
2. Any thought on the Krugman argument justifying temporary protectionism under a liquidity trap?
In my opinion, a trade war is not as bad as it seems for China. Everything will be blamed on foreign trade policies instead of Chinese government. And the best thing about the current economic crisis or a trade war is that they force the Chinese government to redistribute wealth. The PBoC and SOEs are not inclined to distribute their fortune unless they are under the threat of massive unemployment and unrest, like now. The redistribution of wealth, be that in a form of implementing universal health care, increased spending on education, establishing pension funds for migrant workers, or handing out purchasing coupons for the rural population, will reduce inequility and ensure China’s long term prosperity.
The over-capacity/production in the U.S. is estimated to be 2.9 trillion over the next 3 years. The situation in Europe and Japan is probably not much better. China’s contribution to global over-capacity,reflected in her trade surplus, is not that great if you consider the scale of the whole thing.
BTW, we do not really know what is in the U.S. and European policy makers’s mind: a weak RMB might be a better choice than a determined Chinese effort to let RMB appreciate and then push it to be an international reserve currency.
Excellent article – I learned a lot from this analysis. I hope the G7 as well as the Chinese leaders read it
The distinction between total and net demand is confusing. Would it read easier if you substitute ‘supply’ instead of ‘total demand’?
China needs to boost internal demand by, for example, raising wages, especially in the rural areas.
It’s ridiculous that there should be such deep poverty in a nation that could afford to give everyone six months paid vacation.
zak822: I often hear the argument that a failure to revalue the yuan (reminbi?)will result in social unrest in China.
I’ve heard that argument, but I don’t believe it. Unlike Latin American countries, China has huge foreign exchange reserves, and can withstand massive capital outflows without having a crisis. This is precisely the reason that I think that it was a good thing that China was slow to appreciate the yuan in the boom times. Now we are in the bust time, China has the option of not depreciating, which it would not have if it didn’t have massive capital reserves.
I’d like to hear an argument as to how depreciation would help Chinese employment. I don’t see how it would because:
a) other countries would match the depreciation causing a downward spiral
b) if depreciation does increase exports then this will slow the recovery in US/Europe. Even if you discount the very real possibility of protectionism slowing the recovery in US/Europe would reduce demand which would decrease exports.
It seems to me that China should follow the policy during the Asian crisis and peg the RMB for the short term (i.e. the next month). Afterwards, we can see how the stimulus package works in the US and in China and then have discussions over currency policy depending on the outcome.
One thing to consider is the employment is a lagging indicator and the time that you would see the most protectionist sentiment is after you have a recovery, but no new jobs. If both the US and China are booming but unemployment is high, it becomes easier to make a political case for protectionism, and the two major bursts of protectionism (in the mid-80′s and in 1992-1993), occurred during jobless recoveries.
Also, I do not thing that either China or the United States are in any position to make any sort of binding agreements regarding open markets in exchange for currency policy. The problem is that the US Treasury could promise anything, but it’s ultimately Congress that decides, and if the Treasury says A, and the Congress does B, then this would suggest bad faith and that would poison things more than no agreement at all.
You also may end up in a situation in which is becomes necessary for China or the US to protect politically sensitive industries. If there is no binding agreement but constant communications, this becomes viable. If you have an agreement that one side sees as binding, then even thinking about doing this leads to accusations of bad faith.
The role of consumption here is important. I understand the surplus manufacturing capacity argument, and I would agree with the fact that right now the world does not need more products but more consumers.
The difficult part is to find the instruments within the Chinese economical system that can accommodate this conversion. People consume on basis of present and future income, and at this point no one with a little economic sense would accelerate their spending.
Now the Chinese government, no matter how powerful it is, cannot force consumption upon it citizens, without an implied warranty that things will not collapse.
At the moment there have been attacks on property retailers and estate agencies, because the price people pay for a home in January is now half of what they paid in July, this angry will turn against the government if they give false hope. So they will move slow.
I may be wrong on this next issue, but then I am sure someone (TwoFish) will correct me.
There has been talk of a high savings rate in China maybe the highest in the world, now I know that the public saving rate is high (your blog mentions it), and if the PBOC are correct, then the private deposits in China have some 2.92 trillion USD in them. This sounds like a lot of money, but if my understanding of the Chinese society is correct, then there is a lot of people to share that money. Now divided by 1.3 trillion or so that means 2 USD per capital to spend, now I know this is false math and I understand that the dividing number is much lower maybe 4-500 million or so, but my point is that domestic private consumption is spread out on a large amount of individuals, which makes a spending decision more difficult and slow. When you spend big money in China – it is not your own money – it is your families.
The best way for the government is to start spending money through its many technology/development programmes like Spark, 863, 963 and The Long-Medium Plan for Technology 2006-2020 and invest huge money into the R&D system, Innovation system, education system etc. this would tie up the youth for a few years and the techno-nationalism is a sure seller among all others.
There has to been strong arguments for changing the economic path, just evoking fear of protectionism is not going to move much inside the CPC, there has to been more to the argument for change, you have to show where the money has to go in the development of domestic demand, if not then the export sector is still the safest bet for now.
RebelEconomist,
I, for one, tire of hearing the “China is more efficient” explanation of its price advantage. I am sure America’s coal industry could be more ‘efficient’ if it tolerated ten of thousands of workers dying per year. US steel producers could also be more ‘efficient’ if China would allow unrestricted coking coal exports. Trixy, above, listed many other factors which china uses to improve ‘efficiency’.
The price differences are predominantly the result of different policies, tolerance, and standards.
In the most basic way, there is little difference in efficiency as demonstrated by productivity figures. Sometimes outsiders see things from a clear perspective….. http://aleph0.clarku.edu/huxley/CE9/CaML.html
Glen M: I, for one, tire of hearing the “China is more efficient” explanation of its price advantage. I am sure America’s coal industry could be more ‘efficient’ if it tolerated ten of thousands of workers dying per year.
In fact, the US coal industry is far, far more efficient than the Chinese coal industry which is why there are fewer American mining deaths. Coal mining is fundamentally a dangerous business, and if you look at deaths per hours mining, the United States and China are roughly comparable. The big difference is that China requires a lot more hours of mining to produce the same amount of coal.
This is also why the Chinese government has met with a lot of resistance from miners when they try to shut down coal mines.
Glen M: US steel producers could also be more ‘efficient’ if China would allow unrestricted coking coal exports.
No. If you make things cheap, then it becomes very inefficient. (And if China started allowing coal exports, then a lot of US coal miners would start screaming.)
US steel making and manufacturing is far, far more efficient than Chinese steel making and manufacturing, which is why the US has so few workers making steel and doing manufacturing.
In general, the US has a much more efficient economy than China’s. However, efficiency is sometimes not a good thing. The more efficient your economy, the fewer workers you need. This is bad if you happen to be a worker.
There is also comparative advantage. The US is more efficient than China at pretty much everything. However you end up with maximum production, if the US focuses at things that it has a 50:1 advantage in, and leaves China to do things that the US has a 2:1 advantage in.
Something about savings rates is that China has some huge savings rates because Chinese corporations are saving large amounts of money. In the late-1990′s China was able to restructure its corporations in ways that may have a lot of lessons for the United States and General Motors.
If you want a “Chinese-style” reform of GM, then the thing to do is to have the government pay for pensions and health care so that GM can focus on making cars.
It will be an extremely foolish policy to devalue Yuan just as the foolish policy of the US side trying to inflate their way out of the recession.
China has no option with regard to Yuan. Yuan has to be slightly appreciated with regard to dollar. This will benefit China in the long run and it will help to solve the huge trade imbalance with China’s trade partners. China must use this world wide recession/depression as a golden opportunity to upgrade its industrial structure. China has the resources to undertake it now and can’t not let a short term difficulty to defer this must-done process. China could emerge from this crisis as the world’s super power in economy if and only if it resists the “easy way out” temptation of devaluing Yuan. After all China can’t even she wants to devalue Yuan since the trade retaliation will surely prohibits it.
Michael,
I read your piece in the FT, very good piece. My question: what specific measures could the Chinese govt take which would show they were trying to adjust their economy to be less export driven, more based in domestic consumption? How do we in the west know they are taking this path? What measures should we expect to see? Thanks.
The next wave of the financial tsunami is now brewing from Eastern Europe. I am trying to assess the threats of it particularly to China. What is your views?
“Now divided by 1.3 trillion or so that means 2 USD per capital to spend”.
Sorry I mean 1.3 billion and 2000 USD per capital No posting after midnight for me, just too many numbers, anyway point stays the same.
Looking at the new NBER paper it seems that the recent appreciation of the Yuan was a result of appreciation of the Euro against the USD. The Yuan was not allowed to float, more like it was allowed to drift.
http://www.nber.org/papers/w14700
“Our results — with the benefit of more recent data and a technique that allows for changes in currency weights as well as changes in the rigidity of the peg — suggest that the regime probably is not best described as a dollar peg with a trend appreciation. Rather, the regime that has recently been in effect is better described as a basket peg with some weight on a non-dollar currency, the euro in particular. By mid-2007, the weight on the dollar had fallen to 0.6 and the weight on the euro had risen correspondingly to 0.4. The euro now apparently plays almost as important a role as the dollar. It follows that the appreciation of the RMB against the dollar in 2007 was attributable to the appreciation of the euro against the dollar, not to a trend effective appreciation of the RMB.”
U.S. Bank Nationalizations – http://www.capitalismgonewild.com/2009/02/bank-nationalization-for-citigroup-and_20.html
Twofish, it’s true that it is possible for China’s fiscal expansion to feed into greater consumption than production, and so cause an increase in net demand, but aside from all the discussion and proclamations over the past three years it is hard to find any evidence that this is happening. On the contrary, total demand is growing and net demand is shrinking. I am not sure I understand the rest of your comment. Claiming that this shows the failure of economic theory is fine and good, and clearly it has become incredibly fashionable to claim the end of this or that economic theory, but I am not convinced that a very standard kind of financial crisis proves any such thing, and more importantly I am not sure I am part of this debate.
Dr. Loo, I think we need to worry a great deal about this. My trip to Washington this week and my many earlier discussions with European and Asian policy types (and I plan to be in Brazil in May) convince me that many people in the world think China is moving in the wrong direction. In my FT OpEd piece on Wednesday I try to argue that even though China seems to be behaving in a predatory fashion, this is not really the case. China’s development model makes it very difficult for it to do the right thing in the short run. As for the impact of the Eastern Europe “tsunami”, it is very worrying indeed, and it is likely to have a significant indirect impact by overwhelming European banks and, in so doing, putting more strains on European consumption.
Tyaresun, I think in the short run deflation is almost a foregone conclusion, although I think whether or not it is in the longer run depends on the robustness of the financial system and on PBoC polices. I am not sure devaluation will have much impact on deflation. I am not smart enough to agree or disagree with Krugman’s argument, but I would say that there is certainly a very strong perception that protection might boost the domestic economy in the short term, and as far as I am concerned it doesn’t matter to China if this perception is right or wrong. What matters is whether or not there will be moves towards protection.
Seatrus, I am not sure what you mean by overcapacity in the US. As far as the global balance of payments goes the US is not an overcapacity country. I am pretty sure that US and European policymakers are not worried about the RMB achieving reserve status, and I am very sure they would not be willing to see domestic unemployment rise to prevent that. The RMB is very unlikely to become a reserve currency in the next few decades for a wide variety of factors. For some reason a lot of people in Asia are obsessed with the importance of reserve currency status and the imagined maneuverings to create this status, but I think this is beyond the point, and perhaps largely the fault of the very silly book, Currency Wars. The RMB will not become a reserve currency because US or European policy makers decide to permit it. It can only become a reserve currency when a large number of countries and companies decide it has the right amount of liquidity, security, and independence (and the last of those three is very unlikely) and if, for some reason, US monetary mismanagement forces people to look for an alternative.
Alaister, by net demand I simply mean demand less supply.
RebelEconomist, I share your frustration with the slow pace at which the US is moving away from areas in which is simply does not have a competitive advantage (and Europe even more), but I guess the political reality is that there will always be opposition to the short-term pain this transition entails, and in a world of rising unemployment this is even more likely to be true. Still, as long as a country’s macro policies are aimed at encouraging production and constraining consumption, it will tend to overcapacity (especially, I would argue, when its working population is growing so much faster than its total population, process that will reverse itself in the next few years) and while this is fine in a world of buoyant demand, under current conditions it cannot help. China needs to change its development model, if for no other reason than to protect itself from over reliance on a perpetual US consumption binge.
Charles, China is a very poor country (not even among the top 100 on a per capita basis) so I am not sure how it can give everyone a six-week paid vacation, let alone a six-month paid vacation, but I certainly agree that China would be much better off in the medium term if wages were to rise, especially in the rural areas. By the way one great positive of the Hu administration versus the Jiang administration is the greater focus on raising rural incomes. They are still growing more slowly than urban incomes but the differential has narrowed sharply.
Lark, there are a number of policies: raise the value of the currency, raise minimum wages, permit workers to organize, raise interest rates, liberalize banking and capital markets, divert greater funding into services and the private sector, extend retail insurance, improve health care pensions, and many others. The problem with all of these, of course, is that many involve short-term pain and all the benefits only occur in the long term. If China were to embark on these it would need to work with the US and Europe to minimize the short term pain – mainly by getting guarantees that they would do nothing to constrain Chinese exports.
This really begs the question of whether a country reduces the value of it currency to expand demand or their companies reduce their prices. What would clearly be a short term solution to the trade deficit would be a sizable reduction in the value of the yuan, which in light of falling demand would trim the surplus. The problem in this world is everyone wants to maintain the status quo, which is defacto bankruptcy while pretending the world still has the purchasing power it had, no one giving anything up. Either we are going to have to come to grips with the fact that the entire system is bankrupt and rule on what the losses are going to be and go forward or we are in for a long depression and most likely trade wars as well. The US, with its reserve currency status has benefitted in an increase in purchasing power over the years, but has been put out as a sitting duck in trade relations. Reserve currencies are world units of trade and without strict debt limit create unsustainable trade imbalances. The great secret is the debt bubble is worldwide and that the dollar is used as currency indirectly around the world. The story is the dollars in China are put into bonds, but in truth the bonds are used by the CCB in the same fashion they are used at the Federal Reserve and a slow down in the accumulation of them would put a stop to the easy expansion of credit in China. Thus the US and China offload inflation on each other, which in the end results in excess debt and more deflation. Playing games with numbers cannot solve this mess. You have an interesting spin on who will wage the trade war and I believe it is maybe the greatest insight I have read on the subject yet and will be included in my thinking going forward.
There seems to be a confusion as to what savings is. I have a problem believing that a country that is building skyscrapers and pays it general employees saves much of anything on a per person basis, but in the general sense of business may save a huge amount due to the fact that the price advantage flows to the top and not the worker. The other side of this coin is that in a financial system savings and debt are equal. Japan, which had a huge savings rate went into deflation due to excessive debt. Who had the debt? The businesses and the borrowers in housing and other real estate took on the debt. Thus we had a system of asset inflation that imploded on itself. How can anything be saved when it is loaned to another to spend? What has driven the Chinese economy and the world economy for decades is the United States credit machine. One can point a finger at the US, but the last 8 years or so was just the final lap in a natural race against time. The asset bubble in the US was so huge that the stock market peak of 2000 was a relative 250% of the 1929 and 1966 peaks and thus should have imploded the world economy then. Is it the fault of the US that the system was set up in a fashion that would eventually bankrupt it,but in the meantime collateralize trade around the world? The securitization and subprime games had already been set in motion in 2000 by one Robert Rubin, formerly of Goldman Sachs, the Secretary of Treasury then as a benefit of his services, employed at a high salary by Citicorp, the biggest financial black hole in the world. The band played on while the ship was sinking. At any point, had they put an end to this procedure, the world would have most likely entered depression.
China is effectively pegging USD for time being, and leaving the decision on Rmb to fundamentals or USA, which I think is the right thing to do, Rmb-USD peg functioned very much like a automatic stabilizer.
1. If US fail to stabilize the financial system and revitalize growth, FED have to resort to massive QE or directly monetarizing treasuries, then gradual weakening of USD should bring RMB down together, and China should keep Rmb pegging reflecting the worsening external environment??
2. If China/USA succeeded in reflating domestic demand through fiscal stimulus-monetary easing, there should be a rebound of China domestic dmmand vs. external, rising import prices vs. export, which should reduce China surging Current account surplus. If some months by 2010 China begin to see trade surplus dropping 50% or more from current USD30B/month pace. coupled with capital flow, FOREX RESERVE SHOULD drop, then China have perfect logic-fundametnals to depeg Rmb-USD and devalue?
[...] Should China Devalue the Yuan? [...]
[...] they don’t. If you are interested in the pros and cons of yuan revaluation, some time ago Michael Pettis wrote a nice article worth revisiting. Basically, all signs economic point toward yuan [...]